Wall Street starts 2017 with tailwind

Thanks to a series of new record highs, the leading U.S. stock market indices had a very successful end of the year. The recent momentum also puts the market in a good position heading into 2017.

The Journal looks ahead and names some favorites.

Time magazine named President-elect Donald Trump as “Person of the Year” for 2016. Though he does not take office until Jan. 20, Trump’s promises and policies have already captured the attention of stock market investors. Trump was not only deemed responsible for the push forward to new record highs in the market (the Dow Jones Industrial Average was close to 20,000 as of this writing), but also for the sector rotation, through which long-neglected parts of the market like financials or cyclical and value stocks have emerged as the new favorites.

In the most significant event, the sellout in the bond market, Trump was also considered to be partly responsible, largely attributed to the fact that the growth-promoting economic policy he strives for would presumably increase inflation as well.

If Trump’s plan proves to be successful, it could create further stock price momentum. After all, in recent years a lot of money went into bonds and comparatively little into equities. Should this trend reverse, it could turn out to be an important price support for equities.

Corporate tax reduction

The importance of Trump’s plan to reduce corporate taxes should not be underestimated. Strategist Ed Yardeni from Yardeni Research has already significantly increased his earnings estimates for the S&P 500 index. In 2017, aggregated earnings are expected to jump to $142 instead of $129, an increase of 20 percent, and in 2018 he expects $150 instead of $136.75. Apart from the expected positive outcome for corporate earnings, Yardeni says it is “important to see if Trump’s tax cuts really do benefit middle-class families and small business owners.”

It remains to be seen, however, which of Trump’s ambitious plans will be realized, since even in his own Republican ranks not everyone shares great enthusiasm for all of his ideas.

Finally, all policies that increase debt significantly or all protectionist measures, which ultimately turn out to be a boomerang, should be viewed with skepticism.

Recession unlikely

Although the trend on Wall Street in 2017 will, to a large extent, depend on what Trump will do, many of the most recent trends were already apparent before his election, including the rise of the inflation expectations and the upturn in the economy. Wall Street may even have headed for new records had there been a different election outcome simply because of the relief connected with the end of the political uncertainty.

That said, the valuation of the stock market can be considered a burden, since the P/E ratio of the market is above average in historical comparison. This should only backfire if there is a recession, a view shared by Sam Stovall, chief investment strategist at CFRA Research. He notes that this bull market is three months from its eighth birthday, a milestone reached by only one bull market since World War II.

“Bull markets don’t die of old age,” he says. “They die of fright. What are they most afraid of? Recession.“

Therefore, it is encouraging that economic models suggest the likelihood for such an event is still relatively low. Based on the recent development of the Philly Fed State Coincident Indexes, that is also the verdict of Veneta Dimitrova, senior U.S. economist at Ned Davis Research.

“Economic growth has broadened across more states, and the improvement has been sustained over the past several months,” Dimitrova says. “Our Recession Probability Model, based on state coincident indexes, edged down to 0.7 percent, indicating practically no odds of recession at this time.“

Bull trend

The Conference Board’s Consumer Confidence Index surged in December as the stock market reached record highs. The Conference Board said last week its consumer confidence index increased to 113.7 in December from an upwardly revised 109.4 in November. There is still plenty of room to run until the overbought 140+ levels (view graph). Bank of America Merrill Lynch views this as bullish in terms of secular sentiment. From this points of views, the road signs on Wall Street are still green. At least the completely intact long-term uptrends in the chart of the leading stock market indices allow no other conclusions.

Bank of America Merrill Lynch even speaks about a secular market trend like that of the 1950s. Technical Research Analyst Stephen Suttmeier continues to view the S&P 500 April 2013 breakout from the 2000-2013 trading range as a secular bull market breakout similar to those from 1980 and 1950, which lasted until 1966 and 2000, respectively. According to him, this means that the secular bull market triggered on the 2013 breakout remains at an early stage, with at least a decade more to run, in our view.

Apart from betting on the U.S. stock market as a whole in 2017, it should again prove to be particularly rewarding to invest in single stocks. In this case, it is important, as always, to pay attention to an advantageous combination of technical patterns, valuation and investment story. Stocks that have met these qualifications include UnitedHealth Group, Altria, General Dynamics, Citigroup, Boeing, Fedex, John Deere, Berry Plastics, Broadcom and Amazon.

As far as sectors are concerned, CFRA Research recommends overweight positions for consumer discretionary, industrials and materials. CFRA also suggests underweighting energy, consumer staples, real estate and utilities.

Analysts at investment bank Jefferies share the positive view of discretionary and industrials. In their opinion, given the dollar’s strength, it makes sense to focus the sector allocation more domestically.